11 April 2017 by Jane Stevensen
Momentum is building behind climate-related financial reporting
Business executives worldwide are watching closely as the Task Force on Climate-Related Financial Disclosures (TCFD) closed the public consultation phase for its recommendations. Released late last year, the recommendations endorse the inclusion of voluntary climate-related financial disclosures in mainstream financial reports and are bound to shape the future of corporate reporting significantly for years to come.
Release of the recommendations, backed by the G20’s Financial Stability Board and led by financial heavyweights Michael Bloomberg and Mark Carney, has increased the momentum behind universal corporate climate reporting. However, many are wondering what this means for companies in practice, and asking whether investors are really that interested when the world appears mired in geopolitical turmoil and financial pressures are increasing.
CDP (formerly the Carbon Disclosure Project) is a UK-based organisation which works with shareholders and corporations to disclose the greenhouse gas emissions of major corporations. CDP believes the work of the TCFD has the potential to be game changing, bringing climate risk directly into the boardroom, and sending the strongest signal yet to global markets that climate risks are indeed financial risks. With nearly 6,000 companies currently disclosing their climate data through the CDP platform, it can see how the TCFD’s recommendations are being viewed, and what the initial reactions are.
“BlackRock last month announced it is adopting climate risk disclosure as one of its top five engagement priorities”
Currently, it is CDP’s spring workshop season and disclosing companies and investors are attending CDP meetings around the world for annual update sessions and to exchange information and ideas. At the Frankfurt meeting in February, attended by more than 100 companies and investors, interest in the TCFD was demonstrably high, with participants wanting clear information on what the recommendations mean for them, and how they should address them within their own organisations.
The level of investor interest can be gauged by BlackRock, the world’s largest asset manager, which last month announced it is adopting climate risk disclosure as one of its top five engagement priorities. This included underlining its support for the TCFD recommendations as ‘a relevant road map for companies’ in this area.
There are four core elements to climate-related financial disclosures that governance professionals hoping to take the TCFD recommendations on board should note:
In the short term, companies must take steps to educate their C-level executives and stakeholders. Key decision-makers need to be sufficiently informed on climate-related topics to ensure that any changes have backing at the very top of the organisation. Companies should also develop scenario analyses to examine the impact on business operations from a range of forward-looking climate scenarios, aligning with the targets set out in the Paris Agreement and Intended Nationally Determined Contributions (INDCs).
“Investors expect companies to outline how they plan to respond to these more stringent national climate policies”
INDCs are individual country commitments to reduce greenhouse gas emissions under the Paris Agreement. These scenarios should be contrasted with business-as-usual temperature projections, that is, the baseline that would occur with no climate action. This effectively brings the future into the present, enabling an understanding of what climate change will really mean for a business and its operations.
Currently, 125 of the 194 signatories of the Paris Agreement have confirmed they will implement the agreement and plan to deliver their INDCs. This will drive more ambitious climate policies across the globe, which will require a strategic response from companies hoping to stay competitive. Investors expect companies to outline how they plan to respond to these more stringent national climate policies.
Scenario analysis should be a top priority for companies in the transition towards a low-carbon world. This is particularly the case for those in high-emitting sectors, such as oil and gas and utilities. The TCFD’s work on climate scenario analysis will further encourage the mainstreaming of this practice. However, there are number of details left out of the TCFD’s recommendations which companies hoping to establish best practice in this area should consider.
In the first instance, companies should strive to align themselves with the International Energy Agency’s 1.5°C scenario (expected to be released mid-2017) to ensure they are on track to lead in a low-carbon economy. The temperature scenarios lay out an emissions trajectory toward limiting the average global temperature increase.
There are significant shortfalls associated with focusing on 2°C scenarios, which would still mean a significantly altered climate, financial risks, and a failure to correlate with the Paris Agreement’s goal of a well-below 2°C world.
Both the 2°C and well-below 2°C scenarios will help companies to develop effective transition plans to ensure they survive and remain competitive in a world aligning with a target of below 2°C temperature rise. They also provide a road map to minimising a company’s own emissions and contribution to climate change. The disclosure of a transition plan enables investors to monitor the company’s progress against its own plan, and also provides a way to benchmark against peers within a sector.
The TCFD references a number of frameworks and metrics that align with its recommendations. However, providing such a broad range for organisations to consider can lead to lack of comparability, where instead there should be some directional prescription for companies to promote universal adoption and comparability. With such a broad selection of metrics, identifying those most relevant for businesses and investors will be critical.
The recommendations currently do not outline a pathway for companies or investors to track and benchmark their climate performance, or address fundamental issues around measurement. Similarly, they do not provide a framework for year-on-year comparability.
“Investors are increasingly asking for sector-level data and benchmarking to inform their investment decision-making”
Companies developing climate reporting frameworks, which want to provide straightforward data to investors, should establish science-based targets, which are decarbonisation targets aligned with keeping global temperature rise below 2°C, and establish internal carbon pricing.
Incorporating science-based targets and carbon pricing in corporate scenario analyses will help develop an actionable pathway on the basis of the risks the company is running and a road map to reaching the target of well-below 2°C temperature rise.
In terms of additional metrics, it is essential they provide a built-in flexibility to allow for individual tailoring to different organisations and sectors. Investors are increasingly asking for sector-level data and benchmarking to inform their investment decision-making. Early corporate adopters providing clear and consistent information are well-placed to benefit in this transition.
Corporates should also consider the benefits of mapping out the carbon footprint of their operations. Although there is disagreement about whether carbon footprinting is the most meaningful indicator for non-financial reporting, it can provide input to other relevant composite indicators.
In order to make the most meaningful use of carbon footprinting it should be both forward and backward-looking, activity-based (for example, examining the impact of products and services sold) and reference science-based targets.
Following the release of the recommendations, the question becomes: what means are necessary to ensure universal disclosure? Companies are already disclosing their climate data to CDP, but so far voluntary methods have failed to achieve universal disclosure. For example, in the UK 95% of FTSE 100 companies report climate data to CDP, but only around two-thirds of the FTSE 350.
It is likely that in order to obtain information which is consistent over time, comparable, and of high quality, policy action to mandate and enforce universal company disclosure will be necessary. Policy intervention by G20 governments has a potentially key role to play in driving global change in corporate behaviour, including in those companies which currently resist voluntary norms.
Both corporates and investors are increasingly aware that runaway climate change poses a business problem, with the potential to impact supply chains negatively and present material risks to portfolios.
In January, an open letter signed by 600 businesses and investors called for the new US administration to fight climate change. The letter argues that failure to build a low-carbon economy will put US prosperity at risk. Investors and corporates alike cannot afford to wait for governments to protect their assets and know that the time to manage this risk is now.
Regardless of whether governments of the G20 throw their weight behind the recommendations, investor engagement means that recent progress on climate disclosure is unlikely to be reversed. Climate risk management is increasingly viewed by investors as an indicator of good corporate governance. As such, they will continue to encourage their investee companies to develop robust climate reporting frameworks, while the recommendations from the Bloomberg/Carney Task Force will accelerate the adoption of streamlined climate reporting globally.
High-quality climate data provides an important tool for companies to ensure their businesses are prepared for the impact of higher carbon taxes, shifting consumer behaviour and natural resource strain.
Global climate reporting frameworks are coming – it is no longer a matter of ‘if’ but rather ‘when’. Corporate governance professionals can help ensure their business is ideally placed in this transition. Preparation and readiness to disclose will position leaders at the forefront and enable the identification of the risks and the new opportunities.